The mortgage foreclosure crisis in this country may have been superseded by events in Japan, Libya and elsewhere for now, but in its own way it’s taking a heavy toll. And it’s likely to get worse, given the context of evidence that an Obama-initiated homeowner subsidy program to stem the tide isn’t working and of a new federal agency poised to extract $20 billion from lenders on behalf of heavily delinquent borrowers. The agency, known as the Consumer Financial Protection Bureau (CFPB), was created by the mostly-misguided Dodd-Frank financial reform legislation signed by President Obama last July. And it’s headed by Harvard law professor-turned-populist zealot Elizabeth Warren, who appears to be making it her personal mission to shake down banks on behalf of borrowers. By all accounts, she has the full weight of the administration behind her.
The housing market will take a while before it fully recovers from the disastrous meltdown of 2007-08. Indeed, in many areas the meltdown never stopped. Some 3.8 million foreclosure notices on nearly 3 million homes went out in 2010, according to the Irvine, Calif.-based RealtyTrac. That 3.8 million represents an increase of 2 percent over 2009 and 23 percent over 2008. And this figure doesn’t include another 7 million or more homes that respected financial analysts such as Laurie Goodman and Alan Abelson say are in or could wind up in the foreclosure pipeline.
There’s more grim news. The Santa Ana, Calif.-based CoreLogic this month revealed that at the end of Fourth Quarter 2010, fully 11.1 million residential properties, or 23.1 percent of all properties with a mortgage, had negative equity. In other words, the amount owed on the loans exceeded the market value of the property, a condition commonly known as being “underwater.” The 23.1 percent figure is up from 22.5 percent for Third Quarter 2010. If home prices fall by another 5 to 10 percent in 2011, as many analysts now project, about a third of all homes in this country will be underwater.
The Obama administration knows these are scary numbers. The problem is that its preferred approaches to warding off calamity are at odds with economic and legal processes that could rectify the situation in a reasonably short time. One approach is the Home Affordable Modification Program, or HAMP. Worked out in consultation with FDIC Chairwoman Sheila Bair and other top federal officials, HAMP, unveiled in March 2009 and launched the following month, is intended to stave off foreclosures and subsequent repossessions by reworking delinquent mortgages on borrower-friendly terms. Policy ought to favor struggling homeowners over struggling banks, the argument went, especially in light of reckless and at times fraudulent practices by institutional lenders.
HAMP may be used for mortgages on primary residences that: meet the current Fannie Mae/Freddie Mac loan purchase ceiling of $729,750; were originated prior to 2009; and have been delinquent for more than 30 days. Participation is voluntary. Applicants may enter the program at any time through 2012, subject to income and other restrictions. A participating homeowner must go through a trial modification lasting 90 days and, if accepted, enter a permanent modification lasting up to five years. Under the latter, a monthly mortgage payment (including property taxes, property insurance and homeowner dues) would represent no more than 31 percent of pretax household income, and could be achieved either by lowering the interest rate, extending the term, or both.
The program ostensibly would produce all kinds of favorable outcomes. Some 3 to 4 million borrowers, and possibly a good deal more, would be able to keep their properties. Banks could avoid having to acquire, manage and sell a huge inventory of potentially unsalable properties. And neighborhoods with high concentrations of troubled mortgages would be stabilized. It seemed like a win-win situation all the way around, fully worth the $75 billion authorization, two-thirds of which would come out of the Troubled Asset Relief Program (TARP) and the other third out of the coffers of Fannie Mae and Freddie Mac, each under federal conservatorship since September 2008.
Two years later, however, the program seems short on winners. A preliminary report by the Treasury Department last August showed that of the 1.3 million trial modifications approved, 616,000 had been cancelled. And through this past December, the program permanently modified only 521,000 mortgages. In addition to the implicit bank-to-borrower subsidies, HAMP has disbursed a little over $1 billion in federal incentive payments to mortgage servicers for making permanent modifications – not that it’s a bad thing that spending has been a small fraction of the authorization. New data suggests this energy has been misapplied. According to the Office of the Comptroller of the Currency and the Office of Thrift Supervision, 33.8 percent of all permanently modified mortgages wound up in default after just six months. Fully 51.4 percent did so after 12 months. The 12-month percentage breakdowns by mortgage type, as reported in the March 15 Wall Street Journal, are as follows: Fannie Mae, 52.5 percent; Freddie Mac, 55.8 percent; government-guaranteed, 62.3 percent; private, 58.2 percent; portfolio loans, 30.1 percent.
Many Republicans want to cut off funding for HAMP. “In an era of record-breaking deficits, it’s time to pull the plug on these programs (like HAMP) that are actually doing more harm than good for struggling homeowners,” said House Financial Services Committee Chairman Spencer Bachus, R-Ala. The Obama administration and allied consumer advocates oppose such action. “Ending HAMP now, without a meaningful alternative in place, would mean that struggling homeowners would have far fewer ways of coping with the worst housing crisis in generations,” remarked Treasury Department Acting Assistant Secretary for Financial Stability Timothy Massad.
Actually, there is a meaningful alternative: financial responsibility. In other words, lenders shouldn’t make loans to mortgage borrowers who pose unsound credit risks. Homebuyers shouldn’t apply for loans that they know they can’t pay back. And the government shouldn’t be conscripting the general population, and particularly responsible homeowners, into subsidizing irresponsible homeowners any more than irresponsible lenders. Were HAMP to “succeed” on its own terms – i.e., prevent or block millions of foreclosures – it would be enabling the very sorts of behavior that led to the current crisis. A successful bailout inevitably creates the basis for future bailouts. A quick demise of the program, by contrast, would speed up the foreclosure and resale processes, and restore the mortgage lending industry to full capitalization. Though foreclosures reached an all-time high in 2010, the December figure for last year was down 26 percent from December 2009, notes RealtyTrac, the largest 12-month drop since the company began publishing foreclosure data in January 2005. This is an almost sure sign that foreclosure delays, and a pending federal-state out-of-court settlement with mortgage servicers that may mandate modification quotas, have had a major impact.
Unfortunately, a problem emerged about a half-year ago. And the response by the Obama administration may severely gum up the works for years. Many mortgage lenders, in their haste to process seemingly insurmountable piles of foreclosure paperwork, have committed factual errors. This highly-publicized “robo-signing” problem, while real, has been overwhelmingly procedural rather than substantive. Few borrowers have lost their homes because of those mistakes. The administration, rather than treat the snafus as manageable, is using them as a pretext for assuming further control over the mortgage industry.
That’s where the new Consumer Financial Protection Bureau comes in. The CFPB, an independent agency within the Federal Reserve System authorized by the Dodd-Frank law, doesn’t formally begin operations until July. But already it is baring its teeth in presumably fulfilling its mission of protecting borrowers from deceptive or fraudulent practices. Nobody disputes the need to investigate and punish willful deception or fraud. But several federal agencies already exist to perform those functions. So what’s the CFPB’s unstated underlying purpose?
Evidence says the motive is mandatory credit allocation. Under Warren’s direction, the bureau recently completed and mailed to Bank of America, JPMorgan Chase, Wells Fargo and other major lenders a 27-page proposed “settlement” that would all but force them into federal receivership. She has received enthusiastic help from at least 10 other federal agencies and all 50 state attorneys general, led by Iowa AG Tom Miller. Not only would the settlement impose extensive reporting and administrative burdens upon the banks, it also would mandate a reduction of outstanding principal for many loans and require lenders to make more loans in lower-income communities. The reported tab: $20 billion.
Treasury Secretary Timothy Geithner is trying to finesse the issue, especially given that Republicans are now in charge of the House of Representatives. In a recent letter to Rep. Bachus, he assured that the CFPB would “not be a party to any formal settlement with mortgage servicers.” But at the same time he admitted at a House Banking subcommittee hearing this past Tuesday that he had asked Warren to advise federal agencies and state attorneys general to collaborate on devising an appropriate settlement with servicers. Her agency, he conceded, has been active in settlement talks.
The Consumer Financial Protection Bureau’s Warren is less subtle. She defends the necessity of her agency this way: “Political attacks against federal and state law enforcement officials for responding to alleged legal violations are dangerous. We know what can happen when laws aren’t fairly or consistently enforced because of political pressure, and it doesn’t end well for American families, businesses, or for the economy.” She insists her agency merely consolidates activities of seven different agencies, thus creating a more efficient way of setting and enforcing rules for responsible lending.
Senate Banking Committee Ranking Minority Member Richard Shelby, R-Ala., sees the issue differently. He accuses Warren of leading “what appears to be nothing less than a regulatory shakedown” of major banks. He and other key Republicans on Capitol Hill have proposed funding her agency through annual appropriations rather than the Fed. Bank of America CEO Brian Moynihan, meanwhile, has criticized the proposed forced principal reductions as “no panacea.” He adds, “When you start helping certain people and don’t help other people, it’s going to be very hard to explain the difference.” Moynihan and other lending executives argue that the provisions of the settlement, taken as a whole, will delay an already lengthy foreclosure process that averaged more than 500 days this past January, according to the Jacksonville, Fla.-based Lender Processing Services. Bank of America estimates the extra wait at 200 days; JPMorgan Chase puts it as high as a full year.
And do the presumed beneficiaries deserve the help? On the whole, one would be hard-pressed to say yes. BoA’s Moynihan states that as many as 80 percent of foreclosure sales during the Second Quarter 2010 involved borrowers who had not made a single payment over the past year. Such a statistic is almost calculated to infuriate homeowners for whom a single late payment is anathema.
The Obama administration, then, can be seen as delivering an expensive carrot-and-stick, one-two punch to bail out borrowers. HAMP represents the “carrot” part, enticing borrowers behind (and often way behind) on their payments to refinance on highly favorable terms. The Consumer Financial Protection Bureau represents the “stick” part, coercing lenders into effectively handing over billions of dollars to borrowers unable to repay their loans, whether or not as HAMP participants. Either way, the result is a major misallocation of resources. In the administration’s egalitarian worldview, however, it’s all about “fairness.”
On one level, it’s unfair to single out the Obama administration for opprobrium. The Bush and Clinton administrations each contributed mightily to the present situation by operating on the assumption that homeownership is a moral right. Federal officials, with prodding from Congress and “civil-rights” groups, combined enticement and intimidation (especially via the Community Reinvestment Act) to encourage banks, thrifts, subprime lenders, Fannie Mae and Freddie Mac to step up lending volume, especially to low- and moderate-income borrowers. Much of this enthusiasm, especially during the Bush years, was driven by an obsession with increasing homeownership rates among blacks and Hispanics. That said, the current administration shouldn’t be absolved of responsibility for aggravating the crisis that had been placed on its lap.
The explosion of defaults, foreclosures and seizures over the past several years, not surprisingly, has reduced the national homeownership rate. From a peak of 69.2 percent in Fourth Quarter 2004, it fell to 66.5 percent in Fourth Quarter 2010. For the time being, this should be seen as a healthy development. While owning a home remains a good long-term investment, delivering a 6 percent average annual return firing 1978-2008, it’s not for everyone. Many people simply can’t, or won’t, repay a mortgage. While slowing down foreclosures will prevent the homeownership rate from slipping further, it also has unintended drawbacks. In a recent working paper titled, “Are Delays to the Foreclosure Process a Good Thing?” economists Eric Higgins (Kansas State University) and Charles Calomiris (Columbia University) answer in the negative. Delays, they conclude, impose hidden costs on homebuyers by: 1) injecting uncertainty among consumers who in turn delay their housing consumption; 2) impeding new construction; 3) creating uncertainly among lenders who in turn are more reluctant to underwrite loans; and 4) exacerbating neighborhood decay.
Undaunted, the current administration is intent on blocking as many foreclosures as possible. Advancing an overarching narrative that casts strapped homeowners as victims of rapacious banks and an unjust economic system, Obama and top officials see it as their moral responsibility to socialize the costs of years of real estate asset overleveraging. With Elizabeth Warren at his side, he’s got an authentic zealot on the case.